Euro flawed from the start, Szász says

Political, economic union go hand-in-hand, Dutch banker says

MarketWatch columnist David Marsh sat down with retired Dutch central banker André Szász for an extensive interview on the roots of the European economic and monetary union, the current European crisis, and its possible outcome.

AMSTERDAM (MarketWatch) — André Szász, long-time board member of the Dutch central bank responsible for international monetary affairs, has witnessed all the major ups and downs of European economics during a career that started in the 1970s.

Here are some excerpts from the interview, which will be published in full in the January issue of the Bulletin of the Official Monetary and Financial Institutions Forum. Read more.

MARSH: My impression is that the politicians who are supervising economic and monetary union [EMU] started up a machine which they didn’t understand — and where they now have lost control. Is it true that you once said that not one of the politicians who agreed the Maastricht treaty in 1991 understood what they were doing? I believe you said also: “And least of all our own prime minister.”

SZÁSZ: I may not have said exactly that, but I certainly believed it. The fundamental problem was that the two main countries concerned — France and Germany — wanted two different monetary unions. The French wanted to influence monetary policy in order to promote higher growth. They didn’t want to get an independent central bank and strong constraints on budgetary policies, but they had to accept that — because that was what was on offer. It had to be that sort of monetary union, or else there would be nothing at all. The French accepted these conditions, instinctively thinking that once that happened and once the Germans could be overruled [through the board of the European Central Bank where the Bundesbank had just one seat], then the constraints that the French had to accept at the beginning of monetary union would automatically become smaller. The Germans, for their part, through the personality of Chancellor Helmut Kohl, were convinced that EMU could start without political union, but once that got under way this would give rise to a dynamic that would force integration in other fields.

Estonia joins the euro club

(1:38)

The Baltic state becomes the 17th country to join the euro zone despite the deepening crisis. Video courtesy of Reuters.

MARSH: If interest rates were too low for the higher-inflation countries in the early EMU years, then they were too high for Germany — one of the reasons for the sluggish early 2000s German economy and the budget overshooting.

SZÁSZ: Exactly. Once you have a monetary policy of one-size-fits-all, interest rates inevitably will not be the right level for everyone. Monetary policy will be in certain cases be too loose and interest rates will be too low; you have to compensate for that with budgetary policy. In Germany at the beginning of EMU, it was the other way around, their interest rates were arguably too high for the German economic situation of the time. The Germans reacted to this by making appropriate adjustments which led then to the revitalization of their economy. The Greeks on the other hand welcomed low interest rates and this encouraged them to borrow more than ever before — without making the appropriate budget adjustments. The bubbles in Spain and Ireland also emerged because interest rates were too low. It was a huge failure of monetary union that budgetary policies were not adjusted to take account of the looseness of monetary policy in such countries.

MARSH: Isn’t there an asymmetry here? The Germans are now going through a higher growth phase. The Germans will not however lose competitiveness at anything like the same pace at which the weaker countries have lost theirs in recent years. So the hoped-for adjustment between the higher- and lower-growing countries will not take place quickly enough to make any difference.

SZÁSZ: I’m not so sure how sustainable the German growth phase will be. As you say, now it is Germany that has a monetary policy that is too loose. It will be the Germans who will suffer the consequences. We will see this in a few years with higher inflation.

MARSH: One of the reasons for EMU was to mitigate the perceived dominance of the Germans. It doesn’t appear to be working out that way.

SZÁSZ: I always thought that monetary union cannot exist by itself. It has to be based on a genuine economic union, and there is no clear-cut boundary between economic union and political union, because economic union deals with issues like public spending, and this goes to the heart of sovereignty. European countries need a form of common foreign policy — and this would have a favorable impact on monetary union.

MARSH: How would this influence the power of Germany?

SZÁSZ: If there is not a gradual development of a common foreign policy, the alternative will not be a bigger role for Paris and London, but a bigger role for Berlin. Germany has a tradition of Ostpolitik. You only have to look at how often [Dmitry] Medvedev and [Vladimir] Putin are in Berlin. And this will continue unless Paris and London see the need for a common foreign policy.

MARSH: So what will be the outcome in the next two years?

SZÁSZ: I do not know. The situation is very worrying. The politicians will do what they can to prevent a serious splitting up, so there’s no real danger right now, because no one thinks that they can afford such an outcome. However, this is clearly not a long-term solution. The problems arose due to a lack of real political consensus on what kind of monetary union we wanted to establish. A real solution can only come as a political answer from the political authorities on the basis of existing treaty obligations.

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